China yields rise sharply on 1-year bill auction

SHANGHAI: China's money market rates and bond yields rose sharply across the curve on Tuesday after the central bank auctioned one-year bills at a higher-than-expected yield.

The bank sold 10 billion yuan ($1.3 billion) of bills in its regular money market operation at 3.0928 percent, above market forecasts of between 3.02 and 3.07 percent. The weekly auction yield had stayed at 2.9760 percent for the past six weeks.

Traders viewed the jump largely as a technical adjustment after Friday's announcement of a hike in benchmark one-year lending and deposit rates by 0.18-0.27 percentage point, which brought the deposit rate to 3.06 percent.

"The hike in deposit rates has raised commercial banks' cost of funding by 15 basis points for one year and 18 bps for three years, so bill yields should theoretically rise by at least those amounts at auctions," said an analyst at a major Chinese bank.

Some in the market were surprised that the central bank had allowed the yield to jump by almost 12 bps at a single auction, especially given the relatively small size of the sale.

But they said there was now less room for the one-year yield to rise at the next auction, so bill yields could climb more slowly in the secondary market in coming days.

"Today's large yield rise reduced expectations for many more substantial rises, so there wasn't a big panic in the secondary market to sell bills," said a trader at an Asian bank.

"The one-year yield at auction could eventually rise to about 3.20 percent, while the three-year yield could rise to about 3.80 percent."

The one-year central bank bill yield in the secondary market was indicated at 3.1056 percent bid on Tuesday, its highest level for at least 23 months, against 3.0610 percent on Monday and 3.0170 percent on Friday, before the rate hike, according to Reuters Reference Rates.

Traders believe the rise in bill yields and the latest 0.5 percentage point hike in reserve ratios, to take effect on June 5, will support the seven-day repo rate around 2.7 percent in coming weeks -- significantly higher than levels around 2 percent which applied a few months ago.

The weighted average seven-day repo slipped to 2.4676 percent by midday from 2.5067 percent on Monday, but traders believe it will resume rising in coming days, hitting about 3 percent before the higher reserve ratios take effect.

In the government bond market, there was little buying because of the belief that the central bank has not finished tightening and yields remain in at least a medium-term uptrend.

Most banks will probably hold off on serious trading until they see the result of Wednesday's auction of seven-year government bonds, traders said.

"Bill yields are expected to continue to rise at auctions, so who would buy bills or bonds in the secondary market at this time?" said a trader at a bank in Nanjing.

Bank of China said in a research note that the bond yield curve should continue to steepen, because the spread between the one-year bill yield and the seven-year bond yield was still narrow compared to April 2004.

"Current expectations of monetary tightening may be comparable to April 2004, when the seven-year bond yield rose above 5 percent and the one-year bill yield was around 3.20 percent, giving a 180 bp spread. So technically the curve steepening trend should continue," it said.

The spread between the one-year bill and the seven-year bond stood at 67 bps on Tuesday, up from 64 bps on Monday.

The five-year government bond yield surged to 3.4880 percent bid, its highest level for at least 23 months, from 3.4073 percent on Monday.